White House Budget Drives Pay for Success and Social Impact Bonds Forward

By Sonal Shah and Kristina Costa
Posted on April 23, 2013, 9:34 am

Media attention following the release of the White House fiscal year 2014 budget last week focused on the big programs and the usual issues: tax provisions, entitlement reforms, and new investments in early childhood education and physical infrastructure. But it is a little-noticed government reform proposal that should be making waves.

The idea is simple and appealing: Pay for Success. In this innovative new approach to financing social programs, government agencies pay for concrete and measurable social outcomes only after they are achieved. Pay for Success mechanisms, such as Social Impact Bonds, leverage private and philanthropic resources to finance social interventions upfront in exchange for a modest return on investment if the program is successful. This ensures that taxpayer dollars truly flow to what works.

Take, for example, a Social Impact Bond aimed at reducing recidivism rates among former convicts. In such an agreement, a city might contract with an outside organization that pledges to achieve a specific, measurable outcome such as reducing the juvenile offender reconviction rate by 15 percent over a period of five years. If the organization is successful, the city will pay an agreed-upon amount, which may be based in part on the anticipated savings in incarceration costs. Pay for Success programs spend government money only on programs with proven results, provide an innovative way to form effective public-private partnerships, and deliver the best outcomes possible at a lower cost to government over time.

This isn’t the first time the White House budget proposed Pay for Success. In fiscal year 2012 there was a modest $100 million request to support Pay for Success models in domestic discretionary spending programs to reduce recidivism, provide workforce training, and combat homelessness. In fiscal year 2013 a similar request was made but for $109 million. Neither of these proposals went anywhere in Congress. In fact, very little attention was given to the idea of Pay for Success, even at a time when budget deficits were a big part of the discussion in Washington.

In this year’s budget proposal, the Obama administration increased support for Pay for Success programs significantly by requesting nearly $500 million to support these programs. The 2014 budget request for domestic discretionary dollars is similar to those in fiscal years 2012 and 2013 and includes a $195 million request this fiscal year in analogous program areas. But the big news is the recently proposed $300 million fund designed to incentivize state and local governments to develop Social Impact Bonds, which will be administered by the Treasury Department.

This minor provision could greatly impact the way our government thinks about and pays for certain social services. A wide range of organizations, from foundations to investment banks to social service providers, see promise in Pay for Success and Social Impact Bonds. These financing tools can provide new capital to scale highly effective social programs, particularly preventive interventions in areas such as homelessness, recidivism, workforce development, health care, education, and other human services.

The Social Impact Bond concept was conceived and tested in the United Kingdom. In 2010 the United Kingdom announced a $13 million deal to bring down recidivism rates among inmates released from Peterborough Prison. Since then the United Kingdom has launched 14 deals to improve everything from foster care to workforce training. The United States enacted its first Social Impact Bond last August in New York City, where Mayor Michael Bloomberg’s administration hoped to reduce recidivism among adolescent males imprisoned at Rikers Island. A host of states, including Massachusetts, Illinois, New York, Texas, Maryland, and New Jersey, are at various stages of exploring how they too can use these programs. Congress hasn’t followed suit, but the new White House budget proposal presents an opportunity for Democrats and Republicans on Capitol Hill to work together to push Pay for Success forward.

Pay for Success and Social Impact Bonds aim to change the way government does business. Governments at all levels in the United States routinely contract out the provision of social services. A study by the Urban Institute found that nearly 200,000 contracts and grants were issued to some 33,000 service providers in 2009. But many social programs and grants aren’t regularly evaluated for effectiveness, even if they track information on program outputs. Of 47 federal programs for workforce development, 41 tracked some outcome measures, but only five programs had completed an impact study since 2004, according to a 2011 Government Accountability Office report.

Pay for Success and Social Impact Bonds include an impact assessment in the funding model since the government does not make payments until positive outcomes are achieved and verified. This allows governments at the local, state, and national levels to pilot new preventive programs with the potential to save money down the line without shouldering all of the financial risk for whether the programs will succeed or fail.

Of course these deals are considerably more complicated than traditional government contracts. First, they begin with a clearly defined, measurable set of outcomes that must be achieved to trigger payment. Second, savings from successful preventive programs can accrue across different budgets and at different levels of government, which causes accounting complications for agencies that wish to use reduced expenditures to repay investors. Third, investors need to assess their appetite for risk with the understanding that some of the deals being considered will adhere to an all-or-nothing model; partial outcomes will not provide partial payments. Finally, different levels of government are best suited to very different roles in Pay for Success, as we recently explained in the Community Development Investment Review. State and municipal governments are much more likely to actually launch Social Impact Bonds, while the federal government’s role is primarily to set standards, galvanize interest, and support the pipeline of deals.

The proposed $300 million Treasury Department incentive fund would be a big deal for Pay for Success in the United States for two reasons. First, the fund would provide incentives for local government by creating a federal budget to partially finance outcome payments for Social Impact Bond deals created by cities and states. This would help mitigate the complicated accounting challenges these agreements pose. Second, the fund would provide credit enhancements for philanthropic organizations’ investments in Social Impact Bonds, offering partial guarantees to reduce the risk that the investor organization will lose all of its capital if a deal fails.

This $300 million Treasury fund, the White House budget explains, is partially modeled on the U.K.’s Social Outcomes Fund. Its £20 million fund “will be used to provide a ‘top-up’ contribution”—a portion of the outcome expenses beyond what any single budget is able or willing to contribute—to help finance payments for complex Social Impact Bond agreements where benefits will cut across multiple budget lines.

To be sure, there are challenges ahead for the proposals in the White House budget and for Social Impact Bonds generally. There’s no guarantee that any part of the White House budget, including Pay for Success, will be enacted by Congress. And Social Impact Bonds are still a work in progress. We need to learn from our experiences with the deals currently in progress in New York, Massachusetts, and elsewhere and continue to modify our approach as we learn what works and what does not. In other words, while Social Impact Bonds are enormously promising, they are not yet proven.

But just because Pay for Success and Social Impact Bonds are complex doesn’t mean we should miss the opportunities they can offer. They provide an improvement, albeit limited, compared to the vast majority of government expenditures on social services that are made without evaluating whether the programs actually work. They allow the government to focus more effort on preventive programs. When budgets get tight, effective preventive services such as reducing reoffending rates among prisoners to break the cycle of recidivism are more likely to get cut than emergency remedial services such as imprisonment. The nearly $500 million the White House proposes for Social Impact Bonds and Pay for Success in a budget that totals $3.7 trillion is a modest proposal with the potential for a tremendous impact.

The Obama administration has taken a big step in proposing the Treasury Department incentive fund, as well as asking for more flexibility in discretionary dollars for Pay for Success financing. These innovative approaches are good for the government, moving them toward paying for outcomes. They are good for nonprofits because they provide more flexible, multiyear funding streams focused on outcomes and not on processes. And they provide an opportunity to align the interests and financing of philanthropic causes and the private sector to achieve real results. Over the next decade the government will be forced to fundamentally change its habits. Rather than relentlessly cutting services, efforts such as Pay for Success provide a good start to finding new ways to effect positive social change.

Sonal Shah is a Senior Fellow at the Case Foundation and at the Center for American Progress. She was previously the director of the White House Office of Social Innovation and Civic Participation. Kristina Costa is Speechwriter to the Chair and Research Assistant in Economic Policy at the Center for American Progress.